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On 8 April 2014, Australia and Korea formally signed their free trade agreement (KAFTA). The day before, Australia concluded negotiations of a trade agreement with Japan referred to as an Economic Partnership Agreement (JAEPA). KAFTA includes investor-state dispute settlement (ISDS) provisions. It is understood that the JAEPA will not.

ISDS provides a tool investors can use to directly enforce investment protections in trade agreements or investment treaties. States, however, may be reluctant to include ISDS provisions as they do not want to open themselves up to potential claims.

We explain why ISDS provisions matter for investors, how investors may utilise the ISDS provisions in KAFTA and the implications of ISDS provisions being omitted from JAEPA.

What is ISDS?

ISDS provides a mechanism for investors making investments in a foreign State (i.e. the Host State) in the event that the State does not protect the investment in accordance with the FTA or an investment treaty. That mechanism enables the investor to bring a claim in international arbitration for damages against the Host State for breach of the FTA or the investment treaty.

Without ISDS, the investor would not have the right to bring a claim against the State under the FTA or investment treaty. The investor may only bring a claim for breach of contract or a claim for breach of a statute or law of the Host State. The investor may be required to bring such claims in the national courts of the Host State.

Australian Government position on ISDS

The previous Australian federal Labor government had announced in April 2011 that it would no longer include ISDS in bilateral investment treaties (BITs) or FTAs. ISDS was not included in the Australia-Malaysia FTA which was entered into by the Labor government in May 2012.

The current Coalition government (elected in October 2013) has indicated it will consider ISDS on a case by case basis. The government is opposed to signing up to international agreements that would restrict Australia’s capacity to govern in the public interest — including in areas such as public health, the environment or any other area of the economy.

Australia has agreed to ISDS in four FTAs, 21 BITs and the Australia-ASEAN-New Zealand Free Trade Agreement. Australia may agree to ISDS in the Trans-Pacific Partnership Agreement (TPP) that is currently being negotiated by the nations that border the Pacific Ocean, including Australia, USA and Japan. Korea has expressed an interest to join the TPP.

Who can use ISDS in KAFTA?

KAFTA provides that an Australian citizen or an Australian company that has invested in Korea may bring a claim for damages in international arbitration against Korea for any actions attributable to the Korean government that were in breach of the investment protections in the KAFTA. Likewise, a Korean citizen or company that has invested in Australia could bring such a claim against Australia.

The investment that is protected may include any type of investment, such as property, intellectual property, shareholdings, claims to money, such as loans, and contractual rights and business concessions, including a concession to search for natural resources.

Korea and Australia have signed KAFTA but it has not yet entered into force. ISDS could only be invoked in relation to claims that arise after KAFTA enters into force.

What claims can be brought under the ISDS provisions in KAFTA?

A claim brought pursuant to the ISDS provisions in KAFTA must be for a breach of the investment protections provided in KAFTA. The investment protections include:

fair and equitable treatment;

full protection and security;

national treatment and most favoured nation (MFN) treatment; and

no expropriation without compensation

The alleged breach may result from action taken by a Korean government body, such as a Department, a local council or a State owned corporation (in some cases) that is contrary to the investment protections included in KAFTA.

For example, expropriation may involve nationalisation of assets or cancelling a licence that effectively shuts down the investor's operations. Unfair and inequitable treatment may include a unilateral and non-transparent change in the law or regulations, such as increasing or imposing new taxes or royalties, or introducing new tariffs.

How is the claim resolved under ISDS in KAFTA?

KAFTA requires an Australian investor to first negotiate its claim with the Korean government. If no resolution is reached, the investor may commence international arbitration against Korea under the ISDS (prior notice requirements apply).

A tribunal will be formed to hear the claim. The tribunal will comprise three independent arbitrators appointed by the parties or by the Secretary-General of the International Centre for the Settlement of Investment Disputes.

What remedies are available for a claim under KAFTA?

If the tribunal finds a breach of KAFTA, it may award damages for the losses suffered by the investor as a result of the breach, plus interest and costs. The tribunal's award will be enforceable against Korea via one of two international conventions (the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards or the International Convention on the Settlement of Investment Disputes).

Korea may, however, claim state immunity when it comes to execution of the award against its assets.

What could the absence of ISDS mean for Australians investing in Japan?

The text of JAEPA is not yet available. The Australian government's key outcomes document for JAEPA mentions that JAEPA will provide investment protections. However, at this point it is not yet clear whether or not it will include the usual investment protections such as fair and equitable treatment, full protection and security, national and MFN treatment and no expropriation without compensation.

Investment protections are included in the Malaysia-Australia FTA even though there are no ISDS provisions.

Even if JAEPA includes the usual investment protections, it is understood that the JAEPA does not include ISDS provisions. This means that Australian investors will not be able to commence international arbitration against Japan in order to enforce any of these protections. As a result, any investment protections in JAEPA may be unenforceable by investors.

Conclusion

ISDS provides foreign investors with an additional means of resolving a dispute if a government interferes with their investment. Threatening or commencing an investment arbitration may be sufficient to compel the State to negotiate an appropriate settlement. If not, it may provide the investor with a remedy for a lost or damaged investment.

Australian and Korean investors may be able to take advantage of ISDS with respect to their investments once KAFTA enters into force. However, it appears that Australian investors in Japan (and Japanese investors in Australia) will be unable to bring such claims under the JAEPA.